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Are Your Services at Risk of Being Subject to North Carolina's New Sales and Use Tax?

The North Carolina General Assembly recently enacted a significant change to the state's sales and use tax that may require you to collect and remit additional tax if you are a service provider. Effective March 1, 2016, the state's sales and use tax applies to the sales price of, or the gross receipts derived from, "repair, maintenance, and installation services" sold at retail in North Carolina. This new legislation modifies prior legislation that taxed service contracts only in limited circumstances, and expands the application of the state's sales and use tax.

In light of this new legislation, if your business includes the sale of "services," it's critical that you evaluate your operations to determine whether you are subject to the new legislation and therefore must collect sales tax from your customers and turn it over to the state. Failure to collect and pay over the tax, if you are required to do so, can result in severe consequences involving the obligation to pay the taxes you should have collected from your own pocket, plus interest and possible penalties.

Some basic questions that you can ask yourself to assist in your determination are addressed in this article.

Do You Provide "Repair, Maintenance, and Installation Services"?

The legislation provides that "repair, maintenance, and installation services" include the following non-exhaustive list of services:

Keeping or attempting to keep tangible personal property in working order to avoid any breakdown and to prevent repairs, such as performing a tune-up on a motor vehicle, lawnmower, or even a bicycle.

Calibrating, restoring, or attempting to calibrate or restore tangible personal property to proper working order or good condition, such as calibrating a watch, medical equipment, thermometer, or a camera.

Troubleshooting, identifying, or attempting to identify the source of a problem for the purpose of determining what is needed to restore tangible personal property to its proper working order or good condition, such as troubleshooting a fluid leak or attempting to identify an unusual noise coming from a motor vehicle.

It's clear from the list of activities above that "repair, maintenance, and installation services" encompasses a broad spectrum of activities.

Are Your Services Sold at Retail?

In order for "repair, maintenance, and installation services" to be subject to the state's sales and use tax, you must not only provide repair, maintenance, and installation services, but you must also be considered to be a North Carolina "retailer." A service provider is considered to be a retailer if the service provider is engaged in the business of delivering, erecting, installing, or applying tangible personal property for use in North Carolina. However, a service provider is not considered to be a retailer if either of the following criteria applies:

The service provider's only business activity is providing repair, maintenance, and installation services and the service provider does not engage in any "retail trade"; or,

The service provider solely operates as a real property contractor as more fully discussed below.

Although the language of the new legislation is not crystal clear, the intent was not to impose the tax on those businesses that are purely service providers but, rather, to tax any repair, maintenance, and installation services that are provided by businesses that are also engaged in the retail sale of personal property.

For example, A Corp. is in the business of, and charges separately for, (1) offering HVAC units for sale to the public ("Units"), (2) installing those Units ("Installation Services"), and (3) providing repairs and maintenance to those Units or existing HVAC units ("Repair and Maintenance Services"). A Corp. will be considered a retailer by virtue of selling the Units and any proceeds derived from selling the Units in North Carolina, and A. Corp.'s Installation Services and the Repair and Maintenance Services will now all be subject to the state's sales and use tax, absent an exception as discussed below.

Do You Qualify for an Exemption?

A. Do You Qualify for an Express Statutory Exemption?

The North Carolina General Assembly has provided that certain activities are not considered "repair, maintenance, and installation services" regardless of their actual nature and, therefore, are not subject to the state's sales and use tax. These activities include:

State safety, compliance, or emission inspections for tangible personal property;

As discussed above, a business is not considered to be a retailer if the business operates solely as a "real property contractor" because the new legislation provides that the installation or application of tangible personal property by a "real property contractor" pursuant to a "real property contract" does not fall within the newly taxable "repair, maintenance, and installation services."

A "real property contractor" is an individual or business that contracts to perform construction, reconstruction, installation, repair, or any other service with respect to real property and furnishes tangible personal property to be installed or applied to real property in connection with the contract, along with the labor necessary to install or apply the tangible personal property that becomes part of real property.

For example, consider A Corp. above. It's in the business of providing construction services pursuant to real property contracts, which includes, among other things, selling the Units and providing the Installation Services. If those construction services were all the services and goods that A Corp. offers for sale as part of its business, then it would be operating solely as a "real property contractor" and would not be considered a retailer. As result, A Corp.'s services, including both the sale of the Units (provided that A Corp. is presented with a proper sales tax exemption) and the provision of the Installation Services, would not be subject to North Carolina sales and use tax.

However, because, in addition to selling the Units and providing the Installation Services, A Corp. also provides the Repair and Maintenance Services, then it is no longer operating solely as a "real property contractor." As a result, the Repair and Maintenance Services offered by A Corp. will be subject to North Carolina sales and use tax.

Note, however, that the sale of the Units and the provision of the Installation Services by A Corp. remain the sale of tangible personal property installed or applied by a real property contractor pursuant to a real property contract and, therefore, such activities, including the provision of the Installation Services, do not constitute "repair, maintenance, and installation services," even though the Repair and Maintenance Services offered by A Corp. are subject to North Carolina sales and use tax. The Installation Services provided by A. Corp. continue to remain free of the state's sales and use tax, provided that A Corp is not considered to be engaged in retail trade as discussed below.

C. Even If You Are a Real Property Contractor, Do You Become Disqualified from Exemption Because You Are Also Engaged in Retail Trade?

If the previous discussion is not confusing enough, the new legislation also includes an exception to the "real property contractor" exemption. Despite the fact that the installation or application of tangible personal property by a real property contractor pursuant to a real property contract does not qualify as taxable "repair, maintenance, and installation services," the General Assembly added an additional hurdle for a real property contractor to qualify for the exception. The new legislation provides that if a service provider is engaged in "retail trade," then the service provider will be considered to be a retailer liable for the charging, collecting, reporting, and remitting of the state's sales and use tax, regardless or whether the service provider also meets the definition of a real property contractor.

If you appear to be a "real property contractor" as described above, but you also perform or provide other services or sell items at retail and thereby you are not operating solely as a real property contractor, then you have to determine whether you are engaged in "retail trade." A business is considered to be engaged in "retail trade" if a majority of the business's trade or business is derived from retailing tangible personal property, digital property, or services to consumers.

Thus, to follow our example of A Corp. above, if more than 50.1% of A Corp.'s total revenue is derived from "retail activities," then, absent one of the other express statutory exceptions, all of A Corp.'s revenue will be subject to North Carolina sales and use tax even if a portion of its business meets the definition of a real property contractor. This would occur if more than 50% of the total revenue of A Corp. comes from the sale of Units (in general and not pursuant to a real property contract) or other items sold at retail, or the sale of its Repair and Maintenance Services. If that is true, A Corp. will be a retailer-contractor, and all of the revenues derived from such retail and contractor activities of A Corp., including the provision of Units and its Installation Services pursuant to a real property contract, then will be subject to the state's sales and use tax.

In summary:

If you provide only construction services pursuant to real property contracts, which includes, among other things, selling and installing new equipment, then your construction services are not subject to the state's sales and use tax pursuant to the real property contractor exemption;

If you provide construction services pursuant to real property contracts, which includes, among other things, selling and installing new equipment, and also provide repair and maintenance services for new or existing equipment, provided that you don't trigger the retail trade exception, then your construction services are not subject to the state's sales and use tax pursuant to the real property contractor exemption, but your repair and maintenance services are subject to the state's sales and use tax;

If you provide construction services pursuant to real property contracts, which includes, among other things, selling and installing new equipment, and also provide repair and maintenance services for new or existing equipment, and the sale of new equipment (in general and not pursuant to a real property contract) or other items sold at retail, or the provision of repair and maintenance comprises more than 50% of your business's total revenue, then all of your revenues derived from such retail and contractor activities are subject to the state's sales and use tax unless one of the other express statutory exceptions apply; or,

If you are engaged in the business of selling tangible personal property unrelated to real property at retail in North Carolina and you also provide repair and maintenance services, then all of your revenues derived from such retail sales and repair and maintenance services are subject to the state's sales and use tax unless an express statutory exception applies.

The recent tax change enacted by North Carolina General Assembly significantly expands the application of the state's sales and use tax and could have a considerable impact on your business operations and, most importantly, your bottom line. Therefore, it is important that you consult with your tax attorney and accountant to better understand these tax implications to ensure that you are in compliance and to consider some strategic business and tax planning options.

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